October 2015

Immigrants are more likely to concentrate around specific industries and entrepreneurship. Market integration and discrimination only go a certain way towards explaining this phenomenon. This column explores how social interactions affect immigrants’ employment decisions in the US. Fifteen ethnic groups are found to cluster around certain industries at a rate 10 times greater than the native population. Immigrants are argued to be drawn to the same industries as their countrymen due to the ease of diffusing skills through social interactions in the group, along with higher earnings due to specialisation.

A number of studies argue that exchange rates matter far less than they used to for trade, or even that they have disconnected altogether. This column presents new research suggesting that, in fact, there is little sign of a disconnect in the relationship between exchange rates and exports and imports; exchange rates still matter for trade. The findings indicate that 10% real effective exchange rate depreciation implies, on average, a 1.5% of GDP increase in real net exports.

The European Banking Union – in all likelihood – is going to involve a European deposit insurance scheme. This column clarifies the different options for organising European deposit insurance and explains what the different options can achieve.

Conventional wisdom tells us that health deteriorates when the economy weakens and improves when it strengthens. Some research tentatively agrees, but there is a marked dearth of challenges and robust research. This column presents new evidence suggesting that the reductions in mortality occurring during typical economic downturns also occur in periods of crisis, adding useful caveats for different types of downturns and crises.

Today the European Central Bank publishes the proceedings of its 2015 Sintra Forum on Central Banking (ECB 2015). In this column the organisers highlight some of the main points from the discussions, including the candid debate between Forum participants that favour a faster pace of structural reforms and the ones that would like to see a more aggressive monetary policy response to real economy developments.

The literature on retirement age has tended to focus on the supply side of the labour market. Using Austrian data, this column examines how firms can influence workers’ retirement decisions through wage structure. Deferred compensations schemes characterised by steeper seniority-wage profiles are found to be associated with workers retiring earlier. Given that early labour market exit is associated with higher costs to social security systems, policymakers could focus on creating incentives for firms to flatten wage profiles.

Though some studies propose that entrepreneurial activity increases during conflicts, macro evidence shows that a conflict is damaging to growth. This column argues that the conflict in Afghanistan did not contribute to economic development because it caused regressive structural changes at the micro level. It reduced employment opportunities and increased self-employment in activities that have low returns. To improve the economic resilience, self-employment in activities that are less affected by conflict should be stimulated.

The Great Moderation is one of the most important changes in the US business cycle since statistics where gathered. This column contributes three main ideas – that output volatility remains subdued despite the tumult created by the Great Recession, that the Great Moderation structural break is found when considering a long historical dataset, and that the nature of the volatility reduction associated with the Great Moderation is linked to the features of expansion phases, in particular, to the absence of high growth recoveries.

The US’s Federal Reserve System was established more than a century ago as a confederation of 12 regional districts. The selection of cities for each region’s Reserve Bank disproportionately favoured the Northeast and the state of Missouri, a fact that remains controversial to this day. This column describes how the existing banking infrastructure and population density at the time, guided the selection of these cities. Modern communication technology has reduced the need for physical proximity between Reserve and commercial banks. Debates about rezoning the Federal districts should therefore focus on the distribution of monetary policymaking authority.

Trust-based agreements and long-term collaborations play a vital role in mitigating inefficiencies from incomplete contracts in global value chains. This column suggests that the possibility to switch partners crucially affects the contractual nature of buyer-supplier relationships. Using transaction-level data of Chinese exporters to the US, it also presents empirical evidence that confirms a positive causal effect of match durations on relational contracting.

Conventional wisdom suggests that there is too little ICT capital in poor countries and evidence show that they are indeed relatively less ICT abundant. This column discusses new evidence that this variation is not unwarranted – deviations from an estimated baseline level of ICT capital are not correlated with per capita income. This suggests that there are no systematic barriers to ICT adoption in low-income countries. They have less ICT capital since their economies are different.

Will the risk-sharing arrangements within the ECB’s quantitative easing programme reduce its effectiveness? The views of leading UK-based macroeconomists are exactly evenly divided on this question, according to the latest survey by the Centre for Macroeconomics. The responses reported in this column suggest that this divergence reflects differences in views about the channels through which quantitative easing operates.

Interest rates have been historically low for decades - long before the financial crisis. What are the causes? And what are the consequences? In this Vox Talk Charlie Bean discusses the findings of the 17th Geneva Report. He argues that the main cause of low interest rates globally is higher savings by the middle aged and that this cause will subside as the middle aged start to retire. But that will take decades and in the meantime there are challenges and risks for monetary policy.

Interest rates are at historic lows in advanced nations around the world and markets expect them to stay low for years. This column introduces the 17th CEPR-ICMB Geneva Report on the World Economy, “Low for Long? Causes and Consequences of Persistently Low Interest Rates”. Written by four world-renowned macroeconomists, the report suggests that real interest rates will eventually return to more normal levels, but in the meantime deflationary traps are more likely, as are financial boom-bust cycles.

Inequality in advanced economies has risen considerably since the 1980s, largely driven by the increase of top earners’ income shares. This column revisits the drivers of inequality, emphasising the role played by changes in labour market institutions. It argues that the decline in union density has been strongly associated with the rise of top income inequality and discusses the multiple channels through which unionisation matters for income distribution.

Europe has a trade policy for solar panels that is designed to level the playing field between Europe and countries like China. This column assesses the EU’s stance. Antidumping policy is supposed to promote a fair competitive environment between domestic import-competing and foreign exporting firms. However, evidence suggests that publicly listed Chinese private sector firms experienced large losses under Europe's import restrictions, while state-owned enterprises experienced little or no adverse impact. Rather than fostering fair competition in green energy products, Europeans have unintentionally tilted the playing field against the Chinese private sector in favour of the state.

The Abe administration has outlined a desire for Japan to rank among the top three OECD countries in the World Bank’s Doing Business ranking. This column uses the Doing Business ranking itself to identify potential reforms the country could pursue to improve its position. Several politically viable, non-judicial reforms could quickly and easily move Japan up in the ranking. The approach highlights how the Doing Business rankings can be used to inform policy reform discussions.

Policy barriers to services trade comprise relatively opaque and hard-to-measure regulations. This column provides novel estimates that reveal that services trade barriers are large but have generally fallen over time, with pronounced differences across sectors and countries. Trade barriers have declined less for small economies and for sectors where initial borders were high.

Philip Lane was appointed today as the next Governor of the Central Bank of Ireland. A frequent contributor to Vox over the years, this column reviews his VoxEU columns that are most relevant to his new post.

Though Japanese firms benefit from a high-quality workforce and invest in R&D as much as their US counterparts, they fall behind US firms in terms of their earning power. This column suggests that corporate structures in the two countries could be an explanation for this phenomenon. The findings indicate that CEOs of US firms aim to maximise profits, whereas CEOs of Japanese firms prioritise long-term corporate survival.

There has always been conflict between macro- and microprudential regulation. Microprudential policy reigns supreme during good times, and macro during bad. This column explains that while the macro and micro objectives have always been present in regulatory design, their relative importance has varied according to the changing requirements of economic, financial and political cycles. The conflict between the two seems set to deepen and so, regardless of which ‘wins’, policymakers must not undermine the central bank's execution of monetary policy.

Unemployment rates vary widely across EU countries. While national institutions and policies explain much of the variation, cultural values, attitudes, and beliefs may also play a role. This column uses survey data from 26 EU countries to investigate the existence of culturally transmitted preferences for work. Country-specific preferences for work are found to have a positive effect on emigrants’ labour market outcomes, with those from countries with an above-average preference for work having higher employment rates abroad. Cultural preferences are significant enough that EU countries may never converge to the same employment rate.

As the tabloid press and broadsheet newspapers often report, executive compensation has grown dramatically since the 1980s and continues to rise in most financial centres. This column looks at how compensating executives has changed in recent years, and suggests ways that governments can collect revenue more effectively in response.

There is no consensus on whether foreign aid is effective in boosting the economy of the recipient country. This column suggests that there is no evidence that aid affects growth. This finding does not imply that aid is necessarily ineffective. Much of the aid is not given to affect growth in the first place, but as humanitarian aid following disasters, to fight terror, please political allies, or influence decisions in important international organisations. Such aid should thus be evaluated with its own goals in mind.

In this column, the IMF's new Economic Counsellor and Director of Research presents the latest World Economic Outlook, which shows how the world economy is at the intersection of at least three powerful forces. First is China’s economic transformation away from export- and investment-led growth and manufacturing, in favour of a greater focus on consumption and services; second is the fall in commodity prices; and third is the impending normalisation of monetary policy in the US.

There is some evidence suggesting a positive effect of services trade liberalisation on the productivity of manufacturing. This column argues that such an effect is conditional on the institutions within a country. Countries with better economic governance benefit more from open services trade policies. Higher quality institutions attract more productive services providers and support higher levels of services performance.

A major aim of cigarette taxes and tobacco control policies is to encourage smokers to quit. It is therefore important to understand the dynamics of quitting decisions in two-smoker couples. This column uses Dutch data to examine whether spousal peer effects exist for smoking cessation decisions. After controlling for the fact that couples are more likely to be similar to begin with, no evidence is found of one partner’s decision to quit affecting their spouse’s decision.

The US debate over income inequality in the 1980s and 1990s focused on the growing disparity between the earnings of the skilled, the unskilled and the super-rich. After the global crash, the decline in labour’s share of national income has been added to these concerns. This column presents an alternative explanation for this decline, arguing that limited substitution possibilities between capital and labour combined with the acceleration in the pace of labour-augmenting technical change raises the effective labour-capital ratio. The policy implications of this alternative explanation are profoundly different from those currently circulating.

A widely held view in academic and policy circles is that openness to international trade and specialisation leads to higher GDP volatility. This column argues that openness to international trade can also lower a country’s GDP volatility by allowing it to diversify its sources of demand and supply, and hence reduce its exposure to domestic shocks.

A large body of research has established a positive link between immigrants and bilateral trade. However, the temporary movement of people across borders has received less attention. This column uses Swedish data to analyse the impact of temporary cross-border movement on trade. Recently arrived migrants are found to reduce the negative impact of distance on foreign trade, by assisting firms to overcome informal and informational barriers to trade with their origin country. Facilitating movement of people across borders can be a highly useful tool for engaging in and benefitting from specialised and internationalised production networks.

The importance of the general public’s inflation expectations is increasingly being emphasised, but surveys of firms’ expectations are notably absent. This column explores the extent to which inflation expectations of firms in New Zealand are anchored. The findings indicate that managers show little anchoring of inflation expectations, despite 25 years of inflation targeting by the central bank. Most managers depend to a large extent on their personal shopping experience to make inferences about aggregate inflation.

Most households lack the skills to make financial decisions and therefore rely on the advice of experts. But do experts provide unbiased recommendations or do they distort their advice to serve their own needs? This column provides evidence that they do distort their advice, using the mortgage market in Italy. If households receive no biased advice, the relative cost of different types of mortgages should be the only variable affecting household choices. But the findings show that characteristics of the lender matter over and above relative prices. This supports the view that banks affect household choices not only through a price channel, but also through an advice channel.

Discussions on the connection between the level of interest rates, incentives to search for yield, and financial stability have been prominent over the last ten years or so. More recently, Larry Summers argued in his 2014 secular stagnation address that the decline in the real interest rates would be expected to increase financial instability. This column addresses the challenging issue of providing an explanation for the connection between these phenomena. An increase in the supply of savings that reduces equilibrium real rates can be associated with an increase in the risk of the banking system. This link can explain the emergence of endogenous boom and bust cycles.

In the aftermath of the Global Crisis, policymakers have adopted policies to limit, or at least manage, capital inflows. This column explores episodes of capital inflows coupled with weak productivity growth, in other words, the financial resource curse. The findings show that once access to foreign capital subsides, the initial boom gives way to a recession. Both investment and employment in the manufacturing sector drop, and the larger the decrease of labour in manufacturing, the sharper the following contraction.

There is reasonable hope that the upcoming United Nations Conference on Climate Change in Paris (COP21) will reach a consistent global climate agreement. What makes the negotiations particularly difficult is not economic efficiency, but the equity implications of climate policy. This column presents a framework for incorporating equity concerns into policy design. Building from four equity principles, it reduces the complex problem of international burden sharing to a simple rule tied to a single metric.

The developing world has notoriously low female-to-male sex ratios, a phenomenon that has been described as ‘missing women’. It is argued that this is driven by parental preferences for sons, sex-selective abortion, and different levels of care during infancy. This column shows that these higher rates of female mortality continue into adulthood. It argues that being unmarried, especially through widowhood, can have substantial effects on relative rates of female mortality in the developing world.

Minting small change was a big, expensive problem in the ancient world. This column argues that the ancient Lydian government and Greek city-states absorbed the cost of producing an extremely wide array of denominations of coins as a political strategy. Governments had much to gain from the spread of coinage in managing budgetary affairs. If it subsidised the mint, an ancient government would make savings in terms of transaction costs.

Economists increasingly stress the importance of investment in intangibles such as human and knowledge capital as a way to stimulate economic growth. This column examines how intangibles contribute to economic growth in Japan and Korea. Though intangible investment has increased in both countries in recent decades, the amount of tangible investment has been greater. This is different from what is observed in western advanced economies, which can be explained by the less developed financial markets in eastern Asia.

There has been lots of discussion about economic growth in developing countries, improved health, and the link between health and growth. But does it matter whether it is men’s or women’s health that is improved? This column argues that it does – targeting health investments on women rather than on men is a strong lever for development policy.

The EU has started conversations on a capital markets union, raising questions about integration of services such as finance. This column argues that regulated services are especially important for the European economy. Europeans will eventually be faced with a choice between maintaining sovereignty and building a single market. Whereas the ‘old’ single market in goods and unregulated services was satisfactorily addressed through standards harmonisation, the new single market challenge is all about regulatory enforcement institutions.

Europe’s refugee crisis has reopened debates about people’s choice of destination when migrating. A particular concern is the extent to which migrants select a host country based on employment prospects and the safety and openness of the society. This column presents evidence of an additional influence – the degree of similarity between migrants’ mother tongues and the language spoken in destination countries. This preference for ‘linguistic proximity’ matters less when migrants move to English-speaking countries.

The global nature of supply chains has rapidly come to dominate international trade. This column presents new evidence on production fragmentation and intra-firm trade. For US corporations, cross-country shipments of goods between units of the corporation are rare, despite the fact that most US manufacturing parents own foreign affiliates in upstream or downstream industries.

Controlled foreign company rules are implemented by countries to prevent adverse profit-shifting activities by multinationals. This column suggests there are unintended consequences of such rules for real investment activity. Using the case of German legislation, the authors find that fixed assets at foreign subsidiaries decline by about €7 million per subsidiary in response to controlled foreign company treatment.

Most sub-Saharan African countries have adopted minimum wage laws. This column argues that this will become increasingly significant for the economy as a whole as the number of covered workers grows, with possible spillover effects to uncovered sectors. Importantly, sub-Saharan Africa displays a bias towards a more aggressive minimum policy relative to the rest of the world. Perhaps due to this, compliance is not very high and the economic consequences of minimum wages are not particularly strong.

The housing market is important for many developed economies, not least in the UK. This column presents new research in search and matching modelling suggesting that the quality of a house-buying match is important in understanding not only the time taken to sell a house, but also the length of time homeowners will live in the new house before their next move. The research should provide economists with new insights into housing market dynamics.

The standard economic argument in favour of a uniform carbon price is efficiency – all agents face the same marginal cost of pollution. Such a price can be achieved either by an emissions trading (cap-and-trade) system or by imposing a tax. This column argues that whether a uniform policy or a mixture of both is optimal depends on a few factors, and most importantly on the nature of stochastic shocks affecting the economy.

We need a strong and resilient global financial safety net to reduce the systemic implications of sovereign crises and allow nations to cope with shocks in order to reap the economic rewards of an integrated system of trade and finance. This column argues that the current arrangements are suboptimal – resembling more of a patchwork than a safety net. Drawing on the experience of central banks during the financial crisis, it offers preliminary policy proposals to enhance the effectiveness of the global financial safety net.

Emerging market firms have borrowed in foreign currency to take advantage of low interest rates. This column argues that when the Fed inevitably raises rates, such borrowing will be a threat to emerging economy financial systems. Yet so long as authorities use their existing prudential tools wisely, the risks appear manageable.

Market liquidity is all about smooth and rapid executions of large transactions. But why is it hard to keep big markets liquid? This column looks at liquidity in fixed-income markets, assesses new trends (as well as the EU’s new market instrument rules), and makes recommendations to policymakers to avoid illiquidity – a timely reminder that the social costs of illiquidity should not be underestimated.

Many models rely on the assumption of nominal price stickiness. But the different definitions of frictions can greatly alter their macroeconomic implications. In this column, price stickiness is modelled as the result of errors due to costly decision-making. Errors in the prices firms set help explain micro ‘puzzles’ relating to the sizes of price changes, the behaviour of adjustment hazards, and the variability of prices and costs. Errors in adjustment timing increase the real effects of monetary shocks, by reducing the ‘selection effect’.

There is a pressing need to understand the characteristics of financial systems that are vulnerable to crises, and the mechanisms through which crises are initiated and propagated. To address such a need, this column presents a new international database on financial fragility for 124 countries between 1998 and 2012. The novelties and main features of the databases are also highlighted.

Does low volatility in financial markets mean that another financial crisis is more likely? And should we be worried when everything is OK? This column presents the first empirical results that find a strong validation of Minsky's hypothesis – obtained from 200 years of historical cross-sectional data – that low volatility increases the likelihood of a future financial crisis by increasing risk-taking.

Mortgage refinancing is one of the main ways households can benefit from a decline in the cost of credit. This column uses the US Government’s Home Affordable Refinancing Program (HARP) as a laboratory to examine the government’s ability to impact refinancing activity and spur household consumption. The results suggest that less creditworthy borrowers significantly increase their spending following refinancing. The authors provide comprehensive evidence that competitive frictions in intermediation sector prevented a large number of such eligible borrowers from benefiting from the programme. To the extent that such borrowers have the largest marginal propensity to consume, allowing them to refinance under the programme could increase overall consumption and alleviate uneven economic outcomes across the country.

An important channel for monetary policy transmission is through mortgage markets. This column illustrates how the effects of an interest rate lift-off, from the zero lower bound, on homeowners depend on three factors: the prevalent mortgage type in the economy (fixed or adjustable rate), the speed of the lift-off, and the inflation rate during the lift-off. This channel of transmission suggests that if the purpose of the lift-off is to normalise nominal interest rates without derailing the recovery, the Federal Reserve Bank and the Bank of England should wait until the economies show convincing signs of inflation taking off. Furthermore, the lift-off should be gradual and in line with inflation.

Malaysia’s fortunes have taken a turn for the worse in recent years, both in manufacturing and across the economy in general. This column argues that the country is moving back to processing its agricultural and mineral resources, and that such ‘premature deindustrialisation’ is mostly policy driven. The biggest concern with such structural shifts is that they lead to low-productivity, low-wage manufacturing. Malaysia must address these issues and improve its business environment if it wants to realise its aspirations.